A trust is an arrangement where the assets left to a beneficiary are managed for their benefit, rather than being paid outright. A Discretionary Trust is an arrangement where the Trustees are given a list of potential beneficiaries, but it is up to the Trustees to decide who actually receives any income or any capital from the trust at any given time.
The trust will state who receives anything left at the end of the trust period (usually 125 years from the date of your death). This is a very effective tool for making provision for family members in a flexible way, and is also tax efficient.
On death, inheritance tax (“IHT”) is payable on the value of your estate, which does not pass to fully exempt beneficiaries.
The first part of the estate, known as the nil-rate band and currently set at £325,000, is taxed at nil per cent, so is effectively tax-free, and anything above this is taxed at 40%.
A widower of a spouse, however, who left less than the nil-rate band to non-exempt beneficiaries will get an uplift in their own nil-rate band – giving up to a maximum of £650,000.
When the potential beneficiary of a discretionary Trust dies (except for a couple of exceptions), there is no tax chargeable on the trust, so the free estate gets the full benefit of the nil-rate band. Discretionary Trusts are assessed for IHT every 10 years. The value at each 10 year anniversary is taxed, but the trust benefits from its own nil-rate band; and the surplus is only taxed at 6%.
Where everything is left to a surviving spouse on the first death, although there is no tax payable then, the value of the estate of the surviving spouse on the second death may well be more than the then applicable nil-rate band, and a tax charge may then arise. There is currently an exemption called a “transferable nil-rate band” under which the surviving spouse may have the benefit of two nil-rate bands; however, in most cases there is a greater advantage in still using a Discretionary Trust in the Will of whichever spouse dies first.
If as much as possible (up to the nil-rate band) is left to a Discretionary Trust on the first death (and any surplus left to the spouse) there will still be no tax to pay on the first death. The value of the trust fund is not taxed on the second death either.
The trustees can lend the trust fund to the surviving spouse, and the only asset of the trust then is the fact that it will be repaid at some future date. The Trustees do need to demonstrate that they do consider and review the arrangement from time to time, and it is sensible to keep minutes of the Trustees meetings.
The surviving spouse to all intents and purposes is in the same position as if they had inherited the whole estate. The loan has to be deducted from their estate on the second death, so preserving the tax saving.
The trustees would usually have an indication in the form of a letter of wishes that the intention is that the surviving spouse will be looked after, first and foremost.
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